The global market in fakes has been pegged at $650 billion annually. Can it ever be stopped?

MINYANVILLE ORIGINAL This week, the National Highway Traffic Safety Administration warned owners of certain Toyota (NYSE:TM), Chevrolet (NYSE:GM), Honda (NYSE:HMC), Ford (NYSE:F), Volkswagen, and Nissan (OTC:NSANY) models that their cars could be fitted with counterfeit airbags.

Though only 0.1% of the American vehicle fleet is said to be affected, tens of thousands of people may unknowingly be relying on airbags that won’t inflate properly, if at all -- and in one case, a counterfeit airbag “fired shards of metal shrapnel on impact,” according to the NHTSA.

The knock-off airbags were imported into the country by Chinese businessman Dai Zhensong, who pleaded guilty to federal charges in February and was sentenced to 37 months in prison.

US authorities have gotten quite serious about stemming the tide of counterfeit goods recently, announcing today that two New Hampshire brothers have been sentenced to federal prison for trafficking in counterfeit Cisco (NASDAQ:CSCO) networking hardware.

Other countries’ law enforcement agencies, however, appear to be having slightly less success in getting rid of fakes.

“It’s a syndicate…they build factories to do that [make fake pesticide],” says Ooi Kok Eng, DuPont’s regional head of research and development, explaining to Cambodia Daily that “counterfeit goods often pose health risks to farmers.”

While researching this story, I was able to obtain a pack of knock-off Cambodian cigarettes bearing a familiar -- though suspiciously spelled -- brand name:

The smokes are fairly amusing, but counterfeits have, in fact, become a threat to national security here at home. Counterfeits Infiltrating the US Military

In this case, “well over 100” counterfeit parts were traced backward through the supply chain, with more than 70% coming from China and roughly 20% of the remaining parts leading to the UK and Canada -- both described in the Levin-McCain report as “known resale points for counterfeit electronic parts from China.”

But, as Larry Loucka -- a Certified Supply Chain Professional and Lean Sigma Master Black Belt who has worked with companies such as Honeywell (NYSE:HON) and Toyota, as well as Raytheon (NYSE:RTN), L-3 (NYSE:LLL), and the US Air Force -- told me, today’s electronics don’t really come from anywhere else.

According to Loucka, who has extensive experience in sourcing equipment from China, counterfeit parts can enter the military supply chain as easily as they can slip into those of any other industry.

“Why should military parts be any different than auto parts, consumer electronics, anything, really,” he told me. “They look right, they’re the right size, the right dimensions, they have the correct certificate, how would you know? It’s a global market and parts are parts.”

That global market has been pegged at $650 billion annually, and the year-old Armed Services Committee report revealed some fascinating details behind the trade:

Much of the raw material of counterfeit electronic parts is salvaged electronic waste (e-waste) shipped from the US and the rest of the world to Hong Kong. From Hong Kong, waste is trucked to cities in mainland China, such as the counterfeiting district of Shantou in Guangdong Province, where electronic parts may be burned off of old circuit boards, washed in the river, and dried on city sidewalks. Once washed and sorted, parts may be sanded down to remove the existing part number, date code (which tells you when a part was made), and other identifying marks. In a process known as “black topping,” the tops of the parts may be recoated to hide those sanding marks. State of the art printing equipment may then be used to put false markings on the parts. When the process is complete the parts can look brand new.

So, will the United States military ever be able to fully rid its supply chain of counterfeit parts?

Not likely.

In 2004, reporter Jen Lin-Liu of technology trade publication IEEE Spectrum, visited the town of Guiyu, also in Guangdong Province, and observed firsthand the success counterfeiting has brought to the area.

“The trade might be easier to stamp out if it weren't actually improving the town's economy,” Lin-Liu wrote. “Signs of prosperity can be seen in the white-tiled buildings lining the dusty streets. In the center of town, several private kindergartens and a gleaming new public high school have opened. Stores sell new motorcycles, which are quickly replacing bicycles as the favored mode of transportation.”

“If the electronic waste business is good, so is ours,” one restaurant owner said. The Epicenter of Global Counterfeiting

Today, some economists believe 8% of China’s GDP comes from the sales of counterfeit goods. An astoundingly realistic level of fakery is proudly displayed in everything from automobiles, to theme parks (there is an exact replica of Disneyland(NYSE:DIS) outside Beijing where management insists its “Minnie Mouse” is not a mouse at all, but a “cat with very large ears”), to Apple (NASDAQ:AAPL) computers (they’ve even managed to produce a knock-off Steve Jobs). One can find fake Nike (NYSE:NKE) shoes and ersatz Duracell (NYSE:PG) batteries, as well as imitation US silver dollars and even bogus fossils.

Take a look at the following description of -- amazingly enough -- bogus Chinese tea:

Of the Moyune district teas there are eight varieties; they are much prized in the American markets, but not so much so in England. Among the most important curiosities in the collection are the counterfeit teas of Canton. These are made of any refuse, such as moistened tea-leaves from the pot, beat up with gum and rice-water in a mortar, coloured with Prussian blue and gypsum, and curled, twisted, or granulated so ingeniously as to counterfeit the most costly varieties.

If you think counterfeiting in China is a relatively recent phenomenon, consider that the above passage is excerpted from a debriefing report from the Juries to Her Majesty’s Commissioners after the Exhibition of the Works of Industry of All Nations, which took place in London -- in 1851.

In March 2011, I spoke with James T. Hayes, Jr., Special Agent-in-Charge of the New York Customs Enforcement Homeland Security Investigations office, whose team recently broke up an international counterfeiting ring which allegedly shipped almost 40,000 bottles of fake brand-name perfumes into the US from Guangdong Province, China.

“Sometimes people will ask why Homeland Security is involved in something like counterfeit perfume,” Hayes told me. “But it’s important to point out that criminal organizations, terrorist organizations, need to get their financing from somewhere. And contrary to what a lot of people may hear and read, a lot of these groups are not state-sponsored. There’s no endless pot of money provided by the government, so trafficking in counterfeit products is a wonderful way to create one. Here you have products that would fetch $60-$70 a bottle on the legitimate market, the counterfeits sell for a third of that, and they’re producing them for a tenth of that.”

The money -- as well as all those involved -- can be extremely difficult to track. However, Hayes said that, in this case -- which resulted in a two-count indictment being handed down yesterday by a federal grand jury against Chinese nationals Shaoxia Huang, Shaoxiong Zhou, and Shaowu Zhou -- luck was on the Department's side.

“Let’s face it -- it’s not easy to get your primary culprits out of a place like China if they don’t want to leave,” he explained. “This time, we found out our suspects were headed to Las Vegas for a trade show where we had set up a buy. In reality, we were buying their arrest.” Buying Fakes Couldn’t Be Easier

Have access to a computer? You, too, can be in the counterfeiting business.

Last summer, I performed a little experiment and headed over to NewportsCigarettes.org (now apparently shut down) which advertised "Perfect American Cigarettes for You," and assured potential buyers:

"We care of our customers and and offer the quality products they may need. You can see an extensive assortment of cigarettes on our website."

The extensive assortment included (ostensibly without the approval of the attorneys general of the states involved) not only counterfeit smokes, but counterfeit smokes with counterfeit tax stamps for pretty much any state you'd like -- just a FedEx shipment away.

I clicked the "Live Help" button and I was chatting with a representative on the other side of the planet far faster than I have ever in my life been able to get a Verizon rep on the phone.

The following is our full, unedited conversation:

you 2011-6-14 11:0:23hello

SalerN0.1(9108666) 2011-06-14 22:59:15hi

you 2011-6-14 11:0:39how long for shipment from china to united states?

you 2011-6-14 11:4:32what is the next step for delivery? make a purchase on your website?

SalerN0.1(9108666)2011-06-14 23:04:18yeh,you can order on our website directly,and then we will ship it out in 24 hours

As always, buyer beware. The Organized Crime and Corruption Reporting Project says lab tests have shown counterfeit cigarettes from China to contain "80% more nicotine and 130% more carbon monoxide," and "impurities that include insect eggs and human feces."

An Uphill Battle

Interestingly, the counterfeit market can impact legitimate industry more permanently than the simple siphoning off of short-term sales.

As one police officer in Yunxiao, China, told a reporter from Slate a few years ago, “For a long time now, a lot of Yunxiao's [counterfeit] cigarettes have gone to Russia. The feedback from Russian customers is that they've gotten used to the fake flavor, and now they don't want the real ones anymore."

Shut down the counterfeit trade in one area, it moves to another. Get rid of one counterfeit product, another brand gets ripped off tomorrow. Where there is money to be made, there are those who will find a way to get it.

As for the strangest fake ever seen? From what I’ve seen, nothing has yet topped this, from attorney Harley Lewin, in a 2004 interview with Bob Simon of 60 Minutes:

“We had prunes the other day. Fake prunes," he said. "Coming from China to Thailand.”

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